Bank of Ireland. Table Of Contents. Major Rating Factors. Outlook. Rationale

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1 Primary Credit Analyst: Nigel Greenwood, London (44) ; Secondary Contact: Alexandre Birry, London (44) ; Table Of Contents Major Rating Factors Outlook Rationale AUGUST 22,

2 SACP bb + Support +1 + Additional Factors 0 Anchor Business Position bb+ Strong +1 GRE Support 0 Issuer Credit Rating Capital and Earnings Weak -1 Risk Position Adequate 0 Group Support 0 BB+/Negative/B Funding Liquidity Average Moderate -1 Sovereign Support +1 Major Rating Factors Strengths: Stable franchise in Ireland with high market share across business lines, and better international business diversity than Irish peers. Relative asset quality performance has proven to be better than Irish peers, and we expect this to continue. Regulatory capital boosted by private investor and government support in Weaknesses: Ongoing reliance on monetary authorities for liquidity and funding support. Capitalization is likely to remain weak, by our measures. Low profitability at a pre-provision level. Loan impairment charges from its domestic mortgage book are likely to keep group charges elevated for the foreseeable future. AUGUST 22,

3 Outlook: Negative Standard & Poor's Ratings Services' negative outlook on Bank of Ireland (BOI) reflects our expectation that the bank will remain loss making in the second half of 2012 and full-year 2013, mainly as a result of continued weak income generation and elevated loan impairment charges. In common with Irish peers, BOI's management is trying to rebuild the financial profile of the bank in the context of a still-weak Irish economy and troubled housing and mortgage markets and we consider that a sustained recovery in balance sheet metrics and earnings measures will be slow, at best. We could potentially lower the ratings on BOI if: We revise our assessment of BOI's anchor to 'bb' from 'bb+', which could arise if we expected its weighted-average loan exposure to Ireland to increase by around 5% (from about 50% today). We believe that BOI will not return to pretax profitability ahead of system peers, which could lead us revise our assessment of BOI's business position to "adequate" from "strong". Capital, according to our measures, erodes by more than we expect thus leading us to revise our assessment of BOI's capital and earnings to "very weak" from "weak". In accordance with our criteria, it would ordinarily require a two-notch downgrade of the long-term sovereign credit rating on the Republic of Ireland (BBB+/Negative/A-2) for us to consider a revision of the long-term counterparty credit rating on BOI. Conversely, a revision of the outlook on Ireland to stable from negative would not automatically lead to a revision of the outlook on BOI. A revision of the outlook on BOI to stable would require clear evidence that capitalization by our measures is stabilizing, asset quality metrics are steadily improving and that the bank's reliance on monetary authorities is materially reducing. Rationale We base our ratings on BOI on the bank's "strong" business position, as defined by our criteria, due to its relative business stability in Ireland and its reasonably diversified revenue profile. We view capital and earnings as "weak," as we expect that the bank's risk-adjusted capital (RAC) ratio, Standard & Poor's preferred measure of capitalization, will remain in the 4.0%-4.5% range by end Our assessment of the bank's risk position is "adequate," in recognition that BOI's relative asset quality performance has not been materially better or worse than peers with a similar economic risk and product mix. We view funding as "average" and liquidity as "moderate" noting its ongoing reliance on monetary authorities. We assess BOI's stand-alone credit profile (SACP) as 'bb'. The issuer credit rating on BOI incorporates a one-notch uplift to reflect the bank's "high" systemic importance in Ireland, which takes into account its material market share in retail deposits in particular, and the potential for further extraordinary support from the Irish government. Anchor: 'bb+' The 'bb+' anchor draws on our Banking Industry Country Risk Assessment (BICRA) methodology and our view of the weighted-average economic risk in the countries in which BOI operates, based on the geographic distribution of its customer loan exposures, which at June 30, 2012 is about: Ireland (50%), U.K. (45%), and the rest of the world (5%). AUGUST 22,

4 The weighted-average economic risk score for these territories is closer to '5' than '6' on a scale of 1-10 (where '1' is the lowest risk and '10' is the highest). The industry risk score for BOI is based solely on its home market of Ireland. In our view, the Irish banking industry is increasingly concentrated among a handful of key players, but profitability is undermined by high competition for deposits and shrinking loan books. Our view of industry risk is further constrained by the regulatory weaknesses that contributed to the economic crisis, as well as the system's relatively weak funding position, where monetary authorities and foreign-owned parents now fill the gap left by the exit of a substantial number of overseas investors. Table 1 Bank of Ireland Key Figures --Year-ended Dec (Mil. ) 2012* Adjusted assets 149, , , , ,389 Customer loans (gross) 104, , , , ,521 Adjusted common equity 5,364 7,070 4,789 2,999 4,876 Operating revenues 924 2,106 2,868 2,605 3,851 Noninterest expenses 842 1,644 1,785 1,387 2,105 Core earnings (787) (1,342) (2,958) (2,416) 238 *Data as of June 30. Relates to period end March 31, N.A.--Not available. N/A--Not applicable. N.M.--Not meaningful. Business position: Leading business position in Ireland We assess BOI's business position as "strong". Business position is the combination of specific features of the bank's business operations that add to or mitigate its industry risk score. BOI's main rated peers active in the Irish banking industry include Allied Irish Banks plc (AIB; BB/Negative/B), Irish Bank Resolution Corporation Ltd. (IBRC; B-/Stable/C), and Permanent TSB PLC (PTSB; B+/Negative/B), together referred to below as "domestic peers" because they are government owned. The broader "Irish peer" group includes foreign owned banks KBC Bank Ireland PLC (BBB-/Negative/A-3) and Ulster Bank Ltd. (BBB+/Negative/A-2). BOI has resilient franchises and high market shares across all retail and commercial banking lines in Ireland. In addition, BOI's U.K. business, which includes a useful source of customer deposits and allows for long-term growth potential, improves its diversity relative to Irish peers in our view. Finally, we note that the Irish government owns 15% of BOI's ordinary shares, compared to over 99% at domestic peers, and that its senior management team is more established. As a result, we assume that BOI should be able to convert its relatively stronger business position into a quicker return to profitability than Irish peers. We consider that BOI's domestic franchise has been enhanced by the significant shake-up of the Irish banking system over the past four years which has led to a smaller numbers of market participants, including the withdrawal of some overseas lenders. In particular, the number of alternative personal current account or small business lending providers has diminished enabling BOI to at least maintain its strong market shares. We also note that in recent quarters BOI has effectively been one of only two lenders of new mortgages, alongside its main competitor Allied Irish Banks PLC (BB/Negative/B). AUGUST 22,

5 Business activity is well spread by business line and we expect this to remain the case (see chart 1). As a result of its receipt of state aid, BOI had to submit an EU restructuring plan, but this did not lead to material changes to its profile. The main outstanding element is to dispose of part of its life division--new Ireland Assurance Company PLC, which distributes life products through independent brokers and its financial advisors--by end Moreover, BOI has addressed the re-capitalization requirements identified by the regulator as part of an industrywide review in March 2011 (Financial Measures Programme) and the related balance sheet deleveraging is well progressed. BOI has stated that it has completed its targeted 10 billion in loan disposals well ahead of schedule. We consider BOI's useful U.K. franchise to be a key differentiator of its profile, relative to Irish peers. While we consider this franchise to be less strong than most rated U.K. banks, and the Retail UK division remains loss making, it is fairly diverse by business activity and also includes a joint venture with the U.K. Post Office which gives BOI an option for potential long-term growth. BOI recently announced that this contract had been extended by a further three years to We recognize that BOI's management team, which has been more stable than most Irish peers through the Irish banking crisis, has made some progress to restore the bank's creditworthiness. However, we believe that it still faces considerable challenges. In particular, pressure on net interest margins remains acute, other income sources appear muted, and a material realignment of the cost base to better reflect the lower business activity remains incomplete. Delivery of strategy also remains susceptible to setbacks in the Irish economic recovery or a downward spiral in the U.K. property market. AUGUST 22,

6 Table 2 Bank of Ireland Business Position --Year-ended Dec (Mil. ) 2012* Total revenues from business line (currency in millions) , ,378.0 N/A N/A Commercial banking/total revenues from business line N.M. N.M. Commercial & retail banking/total revenues from business line N.M. N.M. Insurance activities/total revenues from business line N.M. N.M. Other revenues/total revenues from business line** (14.4) N.M. N.M. Return on equity (28.2) 0.6 (14.7) (61.6) 1.4 *Data as of June 30. Relates to period end March 31, Corporate & Treasury Division. Retail Ireland and Retail UK Divisions. Bank of Ireland Life Division. **Group Centre. N.A.--Not available. N/A--Not applicable. N.M.--Not meaningful. Capital and earnings: Downward pressure on our projected RAC We view BOI's capital and earnings as "weak*". By our measures, BOI's capitalization is not as strong as that implied by a reported core Tier 1 ratio of 14.9% at June 30, 2012 (or a reported 14.0% under a more conservative measurement defined in the Financial Measures Programme). Irish banks are required to maintain a minimum regulatory core Tier 1 ratio of at least 10.5%. Through end-2013 we expect BOI's RAC ratio to remain in the 4.0%-4.5% range. We do, however, assume that BOI's projected RAC should remain well above the 3% threshold which we assign for a "very weak*" assessment. *When a bank's anchor, derived from our BICRA methodology, is in the 'bb' category and its common equity regulatory Tier 1 ratio is greater than the local regulatory requirements, a "weak" assessment of capital and earnings has a minus one-notch impact on the SACP, rather than two (see paragraph 88 of our bank criteria). The impact is minus two notches if we assign a "very weak" assessment, which includes a projected RAC ratio of less than 3%. There are two primary reasons for the large difference between our capital analysis and BOI's regulatory capital. First, within our calculation of total adjusted capital, we exclude 1.8 billion of preference shares issued by BOI to the Irish government and we also exclude 1.35 billion of tax loss carryforwards. On this basis we estimate that total adjusted capital at June 30, 2012 was just under 5.5 billion, which compares to reported regulatory Core Tier 1 capital (before supervisory deductions) of 9.2 billion. Second, within our calculation of risk-weighted assets we apply more conservative risk weightings to reflect our view of economic risk within Ireland. As a result, we estimate that BOI's RAC ratio was about 4.5% at this date (down from 5.3% at year-end after taking into account the large first-half loss, offset in part by our assumption that Standard & Poor's risk-weighted assets (RWAs) experienced the same 8% decline in regulatory RWA over that period). We expect BOI's RAC to be in the 4.0%-4.5% range through end Our forecast for BOI's projected RAC includes the following assumptions: BOI will be more profitable at a pre-provision level than it was in the first half of 2012, but not materially so. Loan impairment charges will remain elevated, but lower in 2013 than the prior two years. We recognize that there is a significant degree of uncertainty in relation to domestic residential mortgage impairment charges, which in part reflects the unknown full impact of the planned new Irish personal insolvency regime. Further losses on de-leveraging will not be material. AUGUST 22,

7 Standard & Poor's RWAs will continue to decline. The 2012 interim results highlighted to us the numerous difficulties that BOI faces to quickly return to profitability. Most notably, reported preprovision profits were a mere 58 million. Like domestic peers, net interest income is negatively affected by the cost of some liabilities being supported by the government's Eligible Liabilities Scheme (ELG). We expect BOI to reduce the quantum of deposits covered under the ELG quicker than domestic peers. Loan impairment charges of 941 million remained at a similarly elevated level to that of the prior two six-month periods. Within this, impairment charges on its domestic mortgage book rose to 291 million from 140 million in the first half of By way of comparison, the charge on its similarly sized U.K. mortgage book was just 19 million. On a reported underlying basis, BOI reported a loss before tax of 907 million in the first half of 2012, which was worse than 722 million in the same period a year earlier. The statutory loss before tax was 1,255 million which takes into account a loss on deleveraging of 206 million and restructuring costs of 66 million, among other items. We consider the quality of capital to be a neutral factor. On the one hand, we believe that the bank now has few attractive assets that it may be able and willing to sell to raise funds. On the other hand, there are virtually no hybrid capital instruments included in total adjusted capital and BOI does have a degree of flexibility afforded by its government preference shares and 1 billion nominal contingent capital notes. Table 3 Bank of Ireland Capital And Earnings --Year-ended Dec (Mil. ) 2012* Tier 1 capital ratio Adjusted common equity/total adjusted capital Net interest income/operating revenues Fee income/operating revenues Market-sensitive income/operating revenues (1.7) (1.7) (4.4) (0.8) (9.5) Noninterest expenses/operating revenues Preprovision operating income/average assets Core earnings/average managed assets (1.0) (0.8) (1.7) (1.7) 0.1 *Data as of June 30. Relates to period end March 31, N.A.--Not available. N/A--Not applicable. N.M.--Not meaningful. Table 4 Bank of Ireland RACF [Risk-Adjusted Capital Framework] Data (Mil. ) Exposure* Basel II RWA Average Basel II RW (%) Standard & Poor's RWA Average Standard & Poor's RW (%) Credit risk Government and central banks 23, , Institutions 16,657 3, , Corporate 44,963 39, , Retail 60,788 11, , Of which mortgage 54,095 7, , Securitization 1, , AUGUST 22,

8 Table 4 Bank of Ireland RACF [Risk-Adjusted Capital Framework] Data (cont.) Other assets 3,514 4, , Total credit risk 151,028 58, , Market risk Equity in the banking book ,063 1,250 Trading book market risk -- 1, , Total market risk -- 1, , Insurance risk Total insurance risk , Operational risk Total operational risk -- 4, , (Mil. ) Basel II RWA Standard & Poor's RWA % of Standard & Poor's RWA Diversification adjustments RWA before diversification 64, , Total Diversification/Concentration Adjustments -- -7,962-6 RWA after diversification 64, , (Mil. ) Capital ratio Capital ratio before adjustments 9, , Capital ratio after adjustments 9, , *Exposure at default. Securitisation Exposure includes the securitisation tranches deducted from capital in the regulatory framework. Exposure and Standard & Poor's risk-weighted assets for equity in the banking book include minority equity holdings in financial institutions. Adjustments to Tier 1 ratio are additional regulatory requirements (e.g. transitional floor or Pillar 2 add-ons). RWA--Risk-weighted assets. RW--Risk weight. RAC--Risk-adjusted capital. Sources: Company data as of Dec. 31, 2011, Standard & Poor's. Risk position: No obvious end in sight to elevated credit risk In the context of peers with a similar economic risk and product mix (we compare BOI with Portuguese banks among others, as well as Irish banks), our assessment of BOI's risk position is "adequate". We take into account BOI's more favorable overall loss experience than some Irish peers because it generally avoided the worst excesses of commercial property and other lending. Net nonperforming assets remain high at about 8% and we expect credit costs to remain elevated. Like Irish peers, BOI has materially reduced its balance sheet in the past couple of years (and like AIB and IBRC has benefited from being able to transfer a meaningful portion-- 10 billion--of its loan book to Ireland's National Asset Management Agency (NAMA; BBB+/Negative/A-2) in the period). Reported gross customer loans have reduced by 22% to billion at June 30, 2012 from billion at Dec. 31, Within this tally, the proportion of property and construction loans has fallen to 19% from 26%. BOI's impairment charges remain well in excess of our estimated normalized losses (which we factor into our capital and earnings assessment). However, we don't overly penalize BOI's risk position because the trend is similar at Irish peers. AUGUST 22,

9 Over the three years to 2011 we calculate by our measures that the average of BOI's ratio of new loan loss provisions to average loans was just over 3%, which compares to well over 5% across the Irish peer group. In the first half of 2012, BOI's reported loss rate was 177 basis points (it was 187 basis points at AIB). The main areas of concern in BOI's loan portfolio, in our view, relate to Irish mortgage, SME, and commercial real estate lending. Residential mortgages account for a fairly high 54% of the gross loan book and are split equally between Irish and U.K. mortgages. The loss rate on Irish mortgages was 210 basis points in the first half of 2012, compared to 159 basis points in full-year While the profile of BOI's domestic mortgage book is broadly in line with the industry (for example, BOI reports that 59% of this book was in negative equity at June 30, 2012), its arrears and forbearance rates are better than the industry average. In stark contrast, the asset quality of its large U.K. mortgage book appears to be holding up well. BOI states that at June 30, 2012, 1.51% of its U.K. mortgages were greater than 90 days past due which compares to a U.K. industry average of 1.94%. The 6% risk-adjusted capital framework (RACF) diversification benefit indicates the geographic diversity of BOI's activities. The RACF does however understate the risk weights for Irish buy-to-let mortgages (25% of BOI's domestic mortgage book at June 30, 2012). BOI states that 14% of its Irish buy-to-let mortgages were greater than 90 days past due at June 30, 2012, compared to 7% of its owner occupied mortgages. Table 5 Bank of Ireland Risk Position --Year-ended Dec (Mil. ) 2012* Growth in customer loans (6.5) (10.1) (10.7) (0.8) (0.6) New loan loss provisions/average customer loans Net charge-offs/average customer loans Gross nonperforming assets/customer loans + other real estate owned Loan loss reserves/gross nonperforming assets *Data as of June 30. Relates to period end March 31, N.A.--Not available. N/A--Not applicable. N.M.--Not meaningful. Funding and liquidity: Still heavily reliant on monetary authorities We regard BOI's funding as "average" and its liquidity as "moderate". We compare funding with the domestic industry average while the liquidity subfactor is compared globally. BOI's reported loan-to-deposit ratio was 136% at June 30, This represents a meaningful improvement from 175% as reported at Dec. 31, BOI is required, by the Financial Measures Programme, to achieve a target loan-to-deposit ratio of 122.5% by end Our assessment assumes that BOI will continue to make progress by reducing its loan book and growing deposits. BOI has a stated net loan book target of about 90 billion (which compares to 98 billion at June 30, 2012). Over the past 18 months, BOI has been able to grow customer deposits to 72 billion from 65 billion and reduce wholesale funding to 53 billion from 70 billion. Customer deposits are largely sourced from retail customers. We also note that near-term senior unsecured debt maturities are very small. Overall, BOI's funding profile compares quite well to the industry average, but is not materially superior, in our view. Our assessment of the bank's liquidity as "moderate" reflects our view that BOI continues to rely heavily on monetary AUGUST 22,

10 authority funding sources, though we do expect this reliance to reduce. Net drawings from monetary authorities were 26 billion at June 30, 2012 or 49% of total wholesale funding. There were no drawings under the exceptional liquidity facilities of the Central Bank during the first half of the year and we assume that this will remain the case. Table 6 Bank of Ireland Funding And Liquidity --Year-ended Dec (Mil. ) 2012* Core deposits/funding base Customer loans (net)/customer deposits Long term funding ratio Broad liquid assets/short-term wholesale funding (x) Net broad liquid assets/short-term customer deposits (14.6) (40.1) (50.2) (20.1) (75.4) Narrow liquid assets/3-month wholesale funding (x) N/A N/A Net short-term interbank funding/total wholesale funding Short-term wholesale funding/total wholesale funding *Data as of June 30. Relates to period end March 31, N.A.--Not available. N/A--Not applicable. N.M.--Not meaningful. External support: High systemic importance in Ireland The long-term counterparty credit rating is one notch higher than the SACP, reflecting our view that BOI has high systemic importance in Ireland and the Irish government is "supportive" of the banking sector, as defined by our criteria. Additional rating factors: None No additional factors affect this rating. Anchor Matrix Industry Risk Economic Risk a a a- bbb+ bbb+ bbb a a- a- bbb+ bbb bbb bbb a- a- bbb+ bbb+ bbb bbb- bbb- bb bbb+ bbb+ bbb+ bbb bbb bbb- bb+ bb bb - 5 bbb+ bbb bbb bbb bbb- bbb- bb+ bb bb- b+ 6 bbb bbb bbb- bbb- bbb- bb+ bb bb bb- b+ 7 - bbb- bbb- bb+ bb+ bb bb bb- b+ b bb+ bb bb bb bb- bb- b+ b bb bb- bb- b+ b+ b+ b b+ b+ b+ b b b- Ratings Detail (As Of August 22, 2012) Bank of Ireland Counterparty Credit Rating BB+/Negative/B AUGUST 22,

11 Ratings Detail (As Of August 22, 2012) (cont.) Junior Subordinated Preference Stock Senior Unsecured Senior Unsecured Subordinated Counterparty Credit Ratings History 20-Jan Dec Jul Feb Nov Sep Jan May Feb Nov Nov Jun-2008 Sovereign Rating Ireland (Republic of) C CC B BB+ D BB+/Negative/B BB+/Watch Neg/B BB+/Negative/B BB+/Watch Neg/B BBB+/Watch Neg/A-2 A-/Negative/A-2 A-/Stable/A-2 A/Watch Neg/A-1 A/Stable/A-1 A+/Watch Neg/A-1 A+/Negative/A-1 A+/Stable/A-1 BBB+/Negative/A-2 *Unless otherwise noted, all ratings in this report are global scale ratings. Standard & Poor's credit ratings on the global scale are comparable across countries. Standard & Poor's credit ratings on a national scale are relative to obligors or obligations within that specific country. Additional Contact: Financial Institutions Ratings Europe; FIG_Europe@standardandpoors.com AUGUST 22,

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